Buying High & Selling Low? That’s What Investors Seem To Do

September 1st, 2002

Many independent investment professionals and academicians have observed that mutual fund investors consistently buy when markets are at their peak and sell when markets are at their bottoms. We can see that observation is true by watching the net flow of money into and out of particular types of mutual funds. While this tendency to buy high and sell low is true of all different types of investors (bond fund investors, growth fund investors, value investors, muni bond investors, etc.), the data in this article is specifically about stock (equity) investors.

If this pattern is really true, shouldn’t we be able to watch what the majority of investors do, and then just do the opposite? As we have all observed, this is easier said than done. Virtually all investors are euphoric at the top and scared at the bottom. At the bottom, investor attitudes are such that there is very little confidence that things will change anytime soon and, therefore, no impetus to invest.

Investor’s Business Daily, in their August 27, 2002 edition, included a table which listed the 11 months with the highest monthly outflow of money from stock mutual funds. With the help of Bloomberg and Lotus, we were able to identify the market returns during the 12 months following the months with the largest outflows. The expanded table appears below.

The table is ranked by �As a % of Total,� where �Total� is the value of all money invested in stock mutual funds. In October 1987, for example, investors withdrew $7.45 billion from stock funds, which was 3.17% of the value invested in all stock funds. You can see that, on a percentage basis, that was about twice as much as investors pulled in the next highest period�July 2002.

The next column over shows what happened in the 12 months following the largest money outflows. In October 1987, for example, the table shows that investors who didn’t sell earned a 9.08% return. As a matter of fact, except for the markets of the last two years, investors have always made money in the year following the months of large outflows.

We also note that investors tend to withdraw more money in the month of August. August is listed in the chart 4 out of 11 times, or about 1/3 of the time. This is not an accident, since August also has the lowest trading volume of the year. Lower activity generally means lower equity prices.

Of course, we don’t know what is going to happen in the next 12 months. But we can observe that money flows out of equity funds and several other indicators of market sentiment are clearly pointed in the right direction.